Mergers and acquisitions are on the increase. Just since January 1, 2013, several major deals have been announced, such as H.J. Heinz being purchased by Brazilian investors and Berkshire Hathaway, US Airways’ proposed merger with American Airlines, and Liberty Global’s acquisition of Virgin Media, to name a few. While none of these deals involved the acquisition of a construction company, history tells us that construction and engineering companies of the United States have been, and likely will continue to be, acquisition targets for foreign companies.
However, the acquisition of a U.S. construction company presents some unique issues that differ from other acquisitions, and that foreign companies should consider and factor into their decision- making process. The purpose of this article is to identify and discuss a few of those issues and highlight potential nuances associated with more typical due diligence arising out of the process of investigating and acquiring a U.S. construction company. While the items and topics addressed in this article do not guarantee a problem-free acquisition with no potential for buyer’s remorse, consideration of the issues should help limit the potential for unexpected problems arising after the deal is closed when the problems of the acquired company become the responsibility of the new foreign owner.
Basic Acquisition Concepts – Motive And Due Diligence
Before addressing some of the specific areas of concern associated with acquiring a US construction company, it is beneficial to have a basic understanding of the potential motives behind an acquisition and the standard practice of assembling a team to perform the necessary due diligence investigation into the target company.
Naturally, there are several strategic reasons that could cause a non-U.S. company to consider purchasing a U.S. construction company. Two of the most common examples would include the desire to break into the U.S. construction market and the desire to expand into a new field of construction (e.g., commercial, industrial, or heavy highway). Such a purchase allows the acquiring company immediate access to one or many markets, depending on the market share of the targeted U.S. construction company and the type of work it performs. This type of acquisition may also improve the purchasing company’s core competence, increase market power, and provide access to complementary resources, to name just a few of the potential benefits.
Considering that the motive for an acquisition will often involve gaining a share in a new or different field of construction, the prudent company (whether foreign or domestic) will assemble a team of professionals to conduct the necessary due diligence related to the purchase of the target company. The best practice in selecting the Due Diligence Team is for the acquiring company to go outside its own staff, because the target company’s business will often involve a different market. This is recommended to help ensure that the Due Diligence Team has the proper expertise and/or knowledge about the new market to appropriately evaluate the potential risks and rewards so that an accurate valuation of the target company can be created.
Although the lineup of Due Diligence Team members may vary depending upon the specialization of the acquisition, certain key team members are almost always involved. For example, standard practice is that the acquiring company’s Team will include an accountant and an appraiser to review the financial information and assets for the purpose of assisting in the determination of whether the purchase price is reasonable. In addition, a real estate professional should be involved in the transaction if any real property is owned by the target company. Finally, counsel for the acquiring company is also typically part of the Due Diligence Team.
As referenced above, however, it is prudent to include at least one specialized person on the Due Diligence Team who has experience in the field of business being acquired when venturing into a new or different field of construction. This member can be critical in advising the Team on industry customs and practices that might be missed by an outsider to the business. Moreover, this person can be critical in identifying the gray areas that will require deeper analysis.
Getting Into The Gray Areas
When the Due Diligence Team has been assembled and charged with looking into the acquisition of a U.S. construction company, the Team for the foreign purchaser must be prepared to dig into the dark corners of the target company. The investigation process is necessary to help uncover the potential problems that may not be readily apparent at first glance given the differences in how companies are run in the U.S. and the types of problems/risks that U.S. construction companies can face in particular industries. The required examination of the target company goes well beyond the balance sheets and determination of the overall corporate financial health that is on the surface of any due diligence investigation. The foreign purchaser must understand details that are deeper than the mere nature of the business itself. The following are two of seven key gray areas that should be explored and fully understood before the purchase is finalized. Part II of this article will appear in the Summer 2013 newsletter, and will examine the remaining five.
Union Labor Agreements
Many areas in the U.S. support construction companies that are “Open Shops” and hire non-union labor. But, for those geographic areas in which the labor unions continue to have a stronghold, understanding the local Labor Agreements that a company has signed onto can be critical to understanding the growth and adaptation potential of the target company. The wages under a Master Labor Agreement could make the target company less competitive in the long term depending upon the remaining duration of the Labor Agreement. While the Labor Agreement remains in place, the ability to adapt and make significant company changes could be limited. Research into these agreements and the specific terms of all such Labor Agreement for all areas in which the target company works can be critical in understanding the future prospects of the target and the constraints with which the foreign company might not be familiar.
Percent Complete For Ongoing Projects
When purchasing an active construction company, it is almost guaranteed that the target company will have several projects in various stages of completion. Understanding how much money has been billed to, and paid by, the project owner is very important in determining the value of the company and the risks associated with taking over those projects. For example, if a project is front-end loaded so that the invoiced percent complete is significantly more than the actual percent complete, then the acquiring company could be stuck making up the differential at the conclusion of the project. Front-end loading is a practice that can be used to increase current revenues and thus, for some, the attractiveness and perceived worth of the target company. However, if the revenue has not truly been earned in terms of completed work, then the cost to complete the project by the acquiring company would likely exceed the amount still owed by the project owner. Under this scenario, the cost of the remaining work on a project or projects would actually surpass the revenue to be earned. A prudent purchaser will dig into the stated percent complete versus actual percent complete on all such existing contracts and use its own people to determine if it is buying into projects of which the cost to complete is going to exceed the remaining earnings.
This article was first published in the IPBA Journal March 2013 Edition and has been reproduced with the permission of the IPBA. This article will be republished in two parts. Part II will appear in the Summer 2013 newsletter.